Solo 401(k) for Self-Employed Business Owners: How It Works and What to Consider
A solo 401k is a retirement plan designed for business owners who have no employees other than themselves and, in many cases, a spouse. For consultants, independent physicians, real estate professionals, freelancers, and owners of small closely held businesses, it can be one of the most flexible ways to save for retirement while managing taxes.
Because a solo 401(k) touches both your business and personal finances, it works best when contribution decisions are made alongside your tax return and your investment plan. This guide explains how the plan works, how it compares with other options, and the questions worth asking before you open one.
Start Here: A Complimentary Business Owner Wealth and Tax Review
Compound offers a complimentary, no-obligation wealth and tax review for business owners. It may include:
Your entity and compensation: sole proprietorship, LLC, S corporation, or partnership, and how you pay yourself
Retirement plan options: solo 401(k), SEP IRA, or other plan designs
Tax planning: how contributions may affect business and personal taxes
Your personal portfolio: how retirement savings fit with investments outside the business
Request your complimentary review.
What Is a Solo 401(k)?
A solo 401(k), sometimes called an individual 401(k) or one-participant 401(k), is a 401(k) plan that covers only the business owner and the owner's spouse. It follows the same basic rules as a larger company plan but without the cost and testing requirements that come with covering employees.
What makes it distinctive is that the owner can contribute in two roles:
As the employee. You can make elective deferrals from your earned income, up to an annual limit set by the IRS. Many plans allow these deferrals to be traditional (pre-tax) or Roth.
As the employer. The business can make an additional profit-sharing contribution based on your compensation. For a sole proprietor, this is based on net self-employment earnings after certain adjustments. For an S corporation owner, it is based on W-2 wages.
Total contributions from both roles are subject to an overall annual limit, and workers age 50 and older can generally make additional catch-up contributions. Because limits change periodically, it is worth confirming current figures each year.
If your spouse earns income from the business, your spouse may also be able to participate, which can increase what a household is able to save.
Who May Benefit From a Solo 401(k) for Business Owners?
A solo 401k for business owners may be worth evaluating if you:
Are self-employed or own a business with no employees other than a spouse
Have significant self-employment income and want to save more than an IRA allows
Want the option of Roth contributions
Have a side business in addition to a regular job (keep in mind that employee deferral limits are generally shared across all 401(k) and 403(b) plans you participate in)
Want flexibility to contribute more in strong years and less in lean years
If you plan to hire employees, the picture changes. Once eligible employees must be covered, the plan may no longer qualify as a solo 401(k), and a different plan design may be needed.
Solo 401(k) vs SEP IRA and Other Self-Employed Retirement Plans
A solo 401(k) is not the only self-employed retirement plan. Common comparisons include:
SEP IRA: Easy to set up and maintain, with employer contributions only. There are no employee deferrals, and Roth SEP contributions are a newer option that not every provider supports. If you have employees, you generally must contribute for eligible employees too.
SIMPLE IRA: Designed for smaller employers with employees, with lower contribution limits and required employer contributions.
Defined benefit or cash balance plans: May allow much larger contributions for some high-income owners, but with more cost, complexity, and required funding.
For some owners with moderate income, a solo 401(k) may allow higher total contributions than a SEP IRA at the same income level because of the employee deferral. The best fit depends on your income, entity type, and goals.
Tax and Administrative Points to Know
Deadlines matter. Rules for when a plan must be established and when contributions must be made differ for employee and employer contributions, and they can depend on entity type. Planning before year end may give you more options.
Reporting. Once plan assets exceed a certain threshold, an annual information return is generally required.
Interaction with other deductions. Retirement contributions can affect other tax items, such as the qualified business income deduction, so modeling the full return matters.
S corporation salary decisions. Because employer contributions are based on W-2 wages, how you set reasonable compensation affects both payroll taxes and retirement contributions.
Clean books. Accurate bookkeeping supports correct contribution calculations. Client accounting services can help keep business records organized.
To see how hypothetical contributions may grow over time under different assumptions, try the Compound calculator. Results are hypothetical and for illustration only.
Investing Inside a Solo 401(k)
A solo 401(k) is often invested more flexibly than a large company plan, depending on the provider. That flexibility makes it more important to coordinate your plan's investments with the rest of your portfolio, including taxable accounts, IRAs, real estate, and the value of the business itself. Many owners already have a large share of their net worth tied to one company, so diversification outside the business deserves attention. Learn more about wealth management for business owners and tax and financial planning for private company owners.
Coordinating Your Business and Personal Plan
Compound brings wealth management, tax planning and preparation, and accounting together so retirement plan contributions, entity decisions, and investments can be reviewed as one plan. For more, see business tax planning in Wisconsin.
Compound works with self-employed professionals and business owners throughout Wisconsin, including Milwaukee, Madison, Green Bay, Appleton, Brookfield, Racine, and Wausau, as well as surrounding areas.
Thinking about a solo 401(k)? Request a complimentary wealth and tax review.
Frequently Asked Questions
Who is eligible for a solo 401k?
Generally, business owners with no eligible employees other than themselves and a spouse. This can include sole proprietors, single-member LLCs, partnerships, and S or C corporations with no other eligible employees.
How much can I contribute to a solo 401(k)?
You can contribute as both employee and employer, subject to annual limits set by the IRS that change periodically. Employer contributions depend on your compensation and entity type.
Does a solo 401(k) allow Roth contributions?
Many plans allow Roth employee deferrals. Check with the plan provider, since not every plan offers this feature.
Is a solo 401(k) better than a SEP IRA?
It depends on your income, entity, and goals. A solo 401(k) may allow higher contributions at some income levels and offers Roth options, while a SEP IRA is simpler to administer.
What happens if I hire employees?
Once you have eligible employees, the plan may need to cover them or be replaced with a different plan design. Review your options before hiring.
Compound is a registered investment adviser. Registration does not imply a certain level of skill or training. This article is for informational and educational purposes only and should not be construed as personalized investment, tax, or legal advice. Tax laws and retirement plan rules are complex and subject to change. Strategies discussed may not be suitable for everyone, and there is no guarantee that any strategy will achieve its objectives or reduce taxes. Calculator results are hypothetical, are not guarantees of future results, and do not reflect any actual investment. Investing involves risk, including possible loss of principal. Diversification does not ensure a profit or protect against loss. Please consult your tax, legal, and financial professionals before acting on any information in this article. For more information, see Compound's Form ADV, available at adviserinfo.sec.gov.
About Compound Wealth
Compound Wealth serves individuals, families, and business owners seeking a coordinated approach to financial planning. By bringing together tax planning, accounting, wealth management, and business transition services, the firm helps clients consider how financial decisions may affect multiple areas of their overall planning strategy.
